This article was originally published in the Anderson Kill Policyholder Advisor Volume 22, Issue 4 (September/October 2013)
The New York Court of Appeals' June 11, 2013 opinion in K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., 21 N.Y.3d 384, 993 N.E.2d 1249 (2013) reiterated a clear message to liability insurance companies: disclaim the duty to defend a policyholder at your own peril. If the insurance company is later found to have done so unjustifiably, K2 Investment Group confirms that the insurance company may not thereafter deny coverage and must instead indemnify its policyholder "even if policy exclusions would otherwise have negated coverage."
New York's Highest Court Reconfirms That Insurance Companies May Need "An Incentive to Defend"
K2 Investment Group arose from a business dispute in which the plaintiff loaned approximately $2.8 million to a corporation, secured by mortgages on property held by the corporation's two principals. The plaintiff, K2 Investment Group, soon discovered the mortgages were not recorded, which prejudiced its rights as a creditor when the corporation defaulted and entered bankruptcy. K2 sued the corporation and the principals. Among the claims asserted by K2 was a cause of action for legal malpractice against one of the principals, an attorney, who had also been responsible for drafting and recording K2's mortgages.
The attorney's legal malpractice carrier, American Guarantee, disclaimed its duty to defend on the grounds that the principal was acting as a businessman, not an attorney, when he neglected to record the mortgages. K2 obtained a default judgment and an assignment of rights from the principal, and it then sued American Guarantee for breach of contract. The trial court granted judgment in favor of K2; the Appellate Division affirmed in full. The Court of Appeals likewise upheld the result, and further clarified and confirmed a remedy espoused nine years earlier in Lang v. Hanover Ins. Co., 3 N.Y.3d 350, 820 N.E.2d 855 (2004):
Estoppel Rule Gaining Steam in the States
K2 Investment Group confirms that the estoppel rule applies in New York, as it does in at least four other states. The Illinois Supreme Court was an early and ardent proponent of this remedy:
(Employers Insurance of Wausau v. Ehlco Liquidating Trust, 708 N.E.2d 1122, 1134-35 (Ill. 1999), citations omitted.)
Ehlco explained how an insurance company's failure to defend a policyholder was not just a breach, but a repudiation, of the contract:
(Id., at 1135, citing Kinnan v. Charles B. Hurst Co., 148 N.E. 12, 14 (Ill. 1925), emphasis added.)
Pulte Home Corp. v. American Southern Ins. Co., 647 S.E.2d 614 (N.C. App. 2007) described North Carolina's approach. A subcontractor's employee sued the general contractor and subcontractor for negligence after falling and injuring himself. The subcontractor's commercial general liability insurance company denied coverage and refused to defend the contractor. American Southern prevailed on summary judgment, but the appellate court reversed:
(Id. at 617, citing Ames v. Cont'l Cas. Co., 340 S.E.2d 479, 486 (N.C. App. 1986).)
The North Carolina court warned that "an insurer undertakes a substantial risk when it chooses not to provide a defense." (Id.) The duty to defend is excused only "if the facts are not even arguably covered by the policy." (Id. at 620, quoting Waste Mgmt. of Carolinas, Inc. v. Peerless Ins. Co., 340 S.E.2d 374, 376 (N.C. 1986).) The court determined that American Southern had a duty to defend its insured, and awarded the contractor the full amount of its settlement with the employee as well as attorney's fees and costs.
Connecticut's implementation of the estoppel rule, termed the "Rule of Messengers," arises from the Connecticut Supreme Court's Missionaries of the Company of Mary, Inc. v. Aetna Casualty and Surety Co., 230 A.2d 21 (Conn. 1967). The court reasoned that an insurance company should not be permitted to benefit from its breach:
(Id., at 26, citing Gray v. Zurich Ins. Co., 419 P.2d 168 (Cal. 1966).)
Reargument of K2 Set for January 2014
K2 Investment Group immediately caught the attention of the insurance industry. American Guarantee moved for reargument, while the Complex Insurance Claims Litigation Association and the American Insurance Association filed a brief as amici curiae in favor of the motion. The Court of Appeals granted the motion without comment and scheduled reargument for January of 2014.
If Defense is Improperly Denied, Estoppel May Obligate the Insurance Company to Pay for the Loss
If paying defense costs is the only consequence an insurance company faces for breaching its duty to defend the insured, an insurance company has a financial incentive to "kick the can down the road." The policyholder is left to defend itself in the underlying action, while simultaneously and separately having to pursue legal recourse against its insurance company. Lang and now K2 Investment Group confirm that New York will no longer abide insurance companies that abandon their policyholders in this way. Anderson Kill will monitor the developments in K2 Investment Group and provide additional commentary when New York's highest court issues its final decision.
About Anderson Kill
Anderson Kill practices law in the areas of Insurance Recovery, Commercial Litigation, Environmental Law, Estate, Trusts and Tax Services, Corporate and Securities, Antitrust, Bankruptcy, Real Estate and Construction, Public Law, Government Affairs, Anti-Counterfeiting, Employment and Labor Law, Captives, Intellectual Property, Corporate Tax and Health Reform. Recognized nationwide by Chambers USA for Client Service and Commercial Awareness, and best-known for its work in insurance recovery, the firm represents policyholders only in insurance coverage disputes – with no ties to insurance companies and has no conflicts of interest. Clients include Fortune 1000 companies, small and medium-sized businesses, governmental entities, and nonprofits as well as personal estates. Based in New York City, the firm also has offices in Ventura, CA, Stamford, CT, Washington, DC, Newark, NJ and Philadelphia, PA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Allen R. Wolff is a shareholder in Anderson Kill's New York office. Mr. Wolff's practice concentrates in construction litigation, insurance recovery, and the nexus between the two, as well as in complex commercial litigation.
Eric R. Reed is an attorney in the firm's Ventura, CA, office. Mr. Reed's practice concentrates in corporate and commercial litigation and insurance recovery, exclusively on behalf of policyholders.
About Anderson Kill
Anderson Kill practices law in the areas of Insurance Recovery, Commercial Litigation, Environmental Law, Estate, Trusts and Tax Services, Corporate and Securities, Antitrust, Bankruptcy, Real Estate and Construction, Public Law, Government Affairs, Anti-Counterfeiting, Employment and Labor Law, Captives, Intellectual Property, Corporate Tax and Health Reform. Recognized nationwide by Chambers USA for Client Service and Commercial Awareness, and best-known for its work in insurance recovery, the firm represents policyholders only in insurance coverage disputes – with no ties to insurance companies and has no conflicts of interest. Clients include Fortune 1000 companies, small and medium-sized businesses, governmental entities, and nonprofits as well as personal estates. Based in New York City, the firm also has offices in Ventura, CA, Stamford, CT, Washington, DC, Newark, NJ and Philadelphia, PA.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.